Bankruptcy Basics

Very Basics Information On Bankruptcy

Any economic system that rewards success has to provide as well for failure. The major industrial nations have long had bankruptcy systems, though they differ dramatically in philosophy and in practice, to liquidate or revive failing businesses and to settle consumer debts when individuals become over-whelmed economically. Countries in transition from planned to free market economies have recognized that a bankruptcy structure is indispensable.
U.S. bankruptcy law attempts to balance the rights of debtors with the rights of their creditors.  Among creditors, balance their competing rights based on the security they hold for the debt and the nature of the underlying obligation. The law determines which creditors will be paid in full, which paid in part, and which paid not at all. The law also declares that some personal obligations are "non-dischargeable" and must be paid regardless of bankruptcy. For individual debtors, these include tax obligations, criminal fines and penalties, alimony and child support, and student loans; corporations must pay administrative expenses, including some wage and benefit obligations to employees, if the company is to be permitted the chance to reorganize. The U.S. Bankruptcy Code contains separate chapters and, often, separate procedures to handle financial failure. Chapter 7 which governs the liquidation of a debtor's assets, is chosen then individuals and businesses filing for bankruptcy. The other chapters provided for reorganization and readjustment of the debt. By law, certain businesses are ineligible for bankruptcy protection: banks, insurance companies, railroads etc. When they become insolvent, they turn to state law or other federal statutes to resolve their obligations.

The Bankruptcy Code

The Bankruptcy Code is complex. A business that hopes to reorganize under Chapter 11 must propose a plan of reorganization that, with rare exceptions, its creditors must vote to accept. In Chapter 11 reorganization, the company will still be operated by the same management but will have creditor and court oversight and public disclosure of business results. In business insolvencies, secured creditors retain their security interests and the promise of a payment at least equal to the value of their collateral. Unsecured creditors generally receive a pro rata distribution that, by law, cannot be less than what they would have received had the company been liquidated. Chapter 11 bankruptcies leave the equity holders in a public company, the shareholders without any payment or dividend. In establishing payment priorities, the bankruptcy law dictates that equity holders be paid last and only if all of the other creditors are paid first and in full. Chapter 11 reorganization can save jobs, provide at least a partial payment to creditors, and possibly maintain the business. The most important part of the Code is the provision that automatically stops all pending litigation or legal proceedings against a company. It brings all of those cases, in effect, into the bankruptcy court where all of a company's assets and its liabilities consolidated and the claims against the company resolved to determine if it can survive. Chapter 11 has been a legal and economic success. Under the law's protection, major department stores, steel companies, airlines, and energy companies have restored themselves and became productive businesses again.

Consumer Bankruptcy

When individuals declare bankruptcy, federal law permits retention of some assets as an exemption. Federal law permits the individual states to give debtors only the exemptions permitted by state law. Chapter 13 has the debtor and creditors agree on a plan for installment payments of all or part of the debt. The debtor obtains a discharge of the unpaid debts only on the successful completion of the plan.